TY - JOUR AU - Malmendier,Ulrike AU - Shanthikumar,Devin TI - Do Security Analysts Speak in Two Tongues? JF - National Bureau of Economic Research Working Paper Series VL - No. 13124 PY - 2007 Y2 - May 2007 UR - http://www.nber.org/papers/w13124 L1 - http://www.nber.org/papers/w13124.pdf N1 - Author contact info: Ulrike Malmendier Department of Economics 549 Evans Hall # 3880 University of California, Berkeley Berkeley, CA 94720-3880 Tel: 510-642-5038 E-Mail: ulrike@econ.berkeley.edu Devin M. Shanthikumar Graduate School of Business Administration Harvard Business School Morgan Hall 377 15 Harvard Way Boston, MA 02163 Tel: 617/495-6856 Fax: 617/496-7363 E-Mail: dshanthikumar@hbs.edu AB - Why do security analysts issue overly positive recommendations? One explanation is that analysts pick their favorite stocks and are truly too optimistic. An alternative explanation is that analysts distort recommendations to maximize trade commissions and underwriting business, particularly if affiliated with an underwriter. We use a novel approach to assess the relative importance of both explanations, exploiting the concurrent issuance of recommendations and earnings forecasts. We first show that small traders follow recommendations but not forecast updates; large traders discount recommendations and follow forecasts. As a result, analysts with conflicting interests may distort recommendations upwards to trigger small-investor purchases and to please management, but may not distort forecasts. They may in fact distort forecasts downwards shortly before the announcement to allow management to beat the forecast. If analysts are, instead, truly too optimistic they should express their positive view both in recommendations and in forecasts. We find that affiliated analysts issue more optimistic recommendations but more pessimistic forecasts than unaffiliated analysts. Moreover, the affiliated analysts who have the most positive recommendations outstanding also give the most negative forecasts, consistent with heterogeneity in incentive distortion but not in optimism. ER -